Financial Markets Abuse & Fraud: US V UK

“Knowledge is power.Advance knowledge is profit.” Rothschild Family

2

The Rothschild´s secured their fortune by accumulating British Government securities on the basis of advance knowledge of Wellington’s victory over Napoleon at Waterloo.

Conflicts Between Market Participants

Information asymmetry occurs when one party to a transaction has information that the other party doesn’t.

Superior information where one party can use that information for their own benefit at the expense of the other.

One party wins, one loses

3

Conduct that Offends the Objectives of Regulation

The need for the market place to be fair, efficient and transparent

Potential to undermine consumer confidence in the market

May lead to Systemic risk

4

Victimless Crime?

Common perception of White Collar Crimes as “victimless” is false!

Value of securities central to free market economy- “demand and supply”

Trading in stock based on inside information can artificially deflate or increase prices

For example, selling may increase downside pressure on prices as others may also follow: “herd mentality”

Arguments for Legalising Insider Trading

Some economists and legal scholars argue that laws making insider trading illegal should be revoked. They claim that insider trading based on material nonpublic information benefits investors, in general, by more quickly introducing new information into the market

Legalization advocates also question why activity that is similar to insider trading is legal in other markets, such as land and housing

6

Insider Trading

City banker nicknamed The Walrus jailed for five years for making a fortune through insider-trading

Asif Butt, 35, was supposed to block information leaks at Credit Suisse First Boston (CSFB), but instead he used his knowledge to make money

He used old school friends to place bets of up to £600,000 often minutes before major financial announcements

Mr Butt has been convicted of making at least £265,000, though the police think the figure is closer to £2m

Mr Butt, was fired by CSFB in January 2002 when evidence of his activities first came to light, and is thought to be the first City compliance officer to be found guilty of insider trading

8

Concluding Remarks Judge`s..

"If investors, large and small, come to the view that they cannot trust the market and that people are habitually stealing a market on them, the health of the financial services industry.....will suffer severely."

9

Financial Services Authority (FSA): "Almost a third of large UK takeover deals show signs of possible insider trading"

 

The UK's financial regulator analysed takeover bids between 2000 and 2004 and said it had found unusual share price movements before about 29% of them

Such movements "suggest some informed trading was going on", said an FSA spokesman

The FSA added that the situation appeared to be

getting worse Another study: FSA researched a total of 1,500

announcements by FTSE 350 members Also found signs of informed trading before

21.7% of announcements by companies listed on the FTSE 350 index between 1998 and 2003 10

A Goldman Sachs analyst, a Merrill Lynch banker and a printer have been arrested charged with insider trading

According to court documents the three, along with another worker at Goldman Sachs, took part in an insider trading plot that made more than $6.7m (£3.8m)

The Goldman workers are alleged to have bribed staff at a printing plant to get early copies of Business Week magazine

The pair are also believed to have paid the Merrill

analyst for inside information on takeovers

11

Barclays Settles SEC Insider Trading Case

Insider trading can happen in lots of different ways, and Barclays Bank PLC chose an interesting one: using information from the creditors committees of bankrupt companies to trade in their debt securities

  Steven Landzberg, a defendant in the case along with

Barclays, was the bank's representative on the creditors committees for six different companies, and as a member received private information about the financial condition of the debtors

  Landzberg's more important job at Barclays was as head of its

U.S. Distressed Debt Desk, which traded the bonds of companies in bankruptcy, making it very hard to resist the opportunity to trade 

SEC took action against Barclays

Barclays settled the case by agreeing to pay over $10.9 million sanctions

12

So what is Insider Trading?

Illegal insider trading refers generally to buying or selling a security while in possession of privileged, material, nonpublic information about the security

Insider trading violations may also include "tipping" such information, securities trading by the person "tipped," and securities trading by those who misappropriate such information

13

Who are Insiders?

A broad range of individuals

A partner in a law firm representing the acquiring company in a hostile takeover bid who traded in target company stock

A Wall Street Journal columnist who traded prior to publication of his column in the stock of companies he wrote about

A psychiatrist who traded on the basis of information learned from a patient.

A financial printer who traded in the stock of companies about which he was preparing disclosure documents

NB: They do not necessarily have to be from the Inside!

14

Who are Insiders?

Can be dichotomized into: Primary: Person who by virtue of their employment or

involvement with a company comes into possession of inside information. Directors, employees, Shareholders, agents contractors etc.,

(US: referred to as ``access insiders``)

Secondary: Person who receives information either directly or indirectly, which they know is inside information and act upon it. Sometimes referred to as ``Tippees``

15

Why Regulate Insider Trading?

Unfair practice to public investors

Prohibiting it promotes efficiency of markets

Property of material information belongs to the corporation for business purposes

Enforce rules of the game

Protect the weak from exploitation by cynical operators.

16

U.S Regulation on Insider Dealing SEC Rules 14.e3 & SEC Rule 10.b5

In the U.S., insider-trading prosecutions are almost all based on the "classical theory" of insider trading:

Purchase or sale of securities with guilty knowledge, while in possession of material, nonpublic information in breach of a duty arising out of a fiduciary relationship to the issuer of the security

The "misappropriation theory" of insider trading:

Misappropriation and trading on the basis of confidential information in a breach of a duty of trust or confidence owed to the source of the information

Under current law and practice, a fiduciary or fiduciary-like relationship (or, in the case of a claim under the misappropriation theory, a "duty of trust or confidence") is required to impose insider-trading liability.

A fiduciary duty is a legal or ethical relationship of confidence or trust between two or more

parties.

Duty of confidence: obliges one party to respect the confidentiality of another. Information obtained may be confidential, and must not be used for personal benefit

U.K. Financial Services and Markets Act 2000

Under Section 118(2) of FSMA, market abuse is when "an insider deals or attempts to deal, in a qualifying investment or related investment on the basis of inside information relating to the investment in question´´

An "insider" is any person who has inside information and he knows, or is reasonably expected to know, is inside information

U.K. Financial Services and Markets Act 2000

"Inside information" is information of a precise nature that

(a) is not generally available, (b) relates, directly or indirectly, to one or more issuers of the

qualifying investments and (c) would, if generally available, be likely to have a significant effect

on the price of the qualifying investments

Information is precise if it indicates circumstances that may reasonably be expected to come into existence or occur, and is specific enough to enable a conclusion to be drawn as to the possible effect of those circumstances

U.S V U.K: The Greenlight Capital Case:

FSA imposed a £7.2 fine on US hedge fund Greenlight Capital Inc. and its owner, David Einhorn, in January 2012 for trading in shares of Punch Taverns plc, a U.K. pubs business, ahead of a planned equity offering

Fine Imposed on the grounds that Greenlight traded on inside information conveyed to Einhorn during a June 2009 conference call with the CEO and corporate broker of Punch. During the call, Greenlight was asked if it would be "wall crossed“

Greenlight declined, and the conference call was conducted on a nonwall-crossed basis. However, during call, Einhorn learned that Punch was considering an equity offering of around £350 million to retire outstanding debt. Prior to the conference call, Greenlight held approximately 13.3% of Punch's shares.

Following the conference call, it reduced its holdings to 9%, which allegedly allowed Greenlight to avoid losses of approximately £5.8 million. The FSA  determined that inside information was conveyed on the conference call and Greenlight traded on this information in violation of U.K. market abuse rules.

The Greenlight Capital Case

US lawyers and hedge fund traders outraged: Did not believe what Mr Einhorn did was illegal

Greenlight's actions are unlikely to have constituted a violation of the U.S. federal securities laws. Greenlight and, by extension, Einhorn were not insiders with a fiduciary relationship based on their shareholdings as Greenlight was a noncontrolling shareholder

Greenlight and Einhorn did not take on any role that would imply a fiduciary duty to Punch, and did not agree to keep confidential the information disclosed or refrain from trading

The Greenlight Capital Case

The FSA concluded Einhorn engaged in market abuse. Einhorn had access to information by virtue of being a Greenlight employee and a fund manager

Trading shares constituted dealing in a qualifying investment. The information was inside information because it:

Was not generally available (being conveyed only during the conference call) and could not have been deduced by market participants;

Related to Punch and its shares; Was precise (the offering was reasonably likely to occur in the near

future) and specific enough to draw a conclusion as to the effect on the share price; and

Would have had a significant impact on the share price had the information been generally available (a sizable equity offering would likely depress the share price).

Difference?

UK

The U.K. approach does not require a fiduciary or fiduciary-like relationship or a duty of trust or confidence between the source and recipient of the information

Wider definition of insider dealing – anyone can be an Insider if they reasonably know they have inside information

Implications of Market Abuse for Financial Markets

If investors are not convinced that the markets are reasonably fair, they will not invest

Societies where individuals do not respect the market rule of law, or where law breakers are not found and punished, find that financial markets cannot develop

In these cases, legitimate businesses operating those countries lack access to capital, cannot invest, cannot create jobs and cannot compete in international markets for their products and services

24

EU Market AbuseOverview

EU Market Abuse Directive

The Market Abuse Directive came into force on 1 July 2005. Aims to fight cross-border market abuse by establishing a common approach among EU member states

Directive deals with insider dealing and market manipulation (together, Market Abuse)

What is Market Abuse?

Seven types of behaviour can amount to market abuse:

1) Insider trading 2) Improper disclosure3) Misuse of information4) Manipulating transactions5) Manipulating devices6) Dissemination 7) Distortion and misleading behaviour

Following examples illustrate Market Abusive behaviour

27

1. Insider dealing

When an insider deals, or tries to deal, on the basis of inside information; Improper disclosure and misuse of information are kinds of insider dealing

For example

An employee finds out that his company is about to become the target of a takeover bid

Before the information is made public, he buys shares in his company because he knows a takeover bid may be imminent

He then discloses the information to a friend. This behaviour creates an unfair market place because the person who sold the shares to the employee might not have done so if he had known of the potential takeover

The employee’s friend also has this information and could profit

unfairly from it 28

2. Improper Disclosure

Where an insider improperly discloses inside information to another person

For example:

An employee finds out that his company is about to become the target of a takeover bid. He then discloses the information to a friend. Before the

information is made public, his friend buys shares in the company because he knows a takeover bid may be imminent.

This behaviour creates an unfair market place because the person who sold the shares to the friend might not have done so if he had known of the potential takeover.

29

3. Misuse of information

Behaviour based on information that is not generally available but would affect an investor’s decision about the terms on which to deal

An employee learns that his company may lose a significant contract with its main customer

The employee then sells his shares, based on his assessment that it is reasonably certain the contract will be lost

This behavior creates an unfair market place as the person buying the shares from the employee might not have done so had he been aware of the information about the potential loss of the contract

4. Manipulating Transactions

Trading, or placing orders to trade, that gives a false or misleading impression of the supply of, or demand for, one or more investments, raising the price of the investment to an abnormal or artificial level

For example

A person buys a large number of a particular share near the end of the day, aiming to drive the stock price higher to improve the performance of their investment

The market price is pushed to an artificial level and investors get a false impression of the price of those shares and the value of any portfolio or fund that holds the stock

This could lead to people making the wrong investment decisions 31

5. Manipulating Devices

Trading, or placing orders to trade, which employs fictitious devices or any other form of deception or contrivance

For example

Buying shares and then spreading misleading information with a view to increasing the price (pump and dump)

Using spam and other illegal marketing such as email and boiler rooms to increase prices

This could give investors a false impression of the price of a share and lead them to make the wrong investment decisions

32

6. Dissemination

Giving out information that conveys a false or misleading impression about an investment or the issuer of an investment where the person doing this knows the information to be false or misleading

For example

A person uses an internet bulletin board or chat room to post information about the takeover of a company

The person knows the information to be false or misleading

This could artificially raise or reduce the price of a share and lead to people making the wrong investment decisions

33

7. Distortion and Misleading Behaviour

Behaviour that gives a false or misleading impression of either the supply of, or demand for, an investment; or behaviour that otherwise distorts the market in an investment

For example

The movement of an empty cargo ship that is used to transport a particular commodity

This could create a false impression of changes in the supply of, or demand for, that commodity or the related futures contract

It could also artificially change the price of that commodity or the futures contract, and lead to people making the wrong investment decisions

34

Thank You

Any Questions?